NEW YORK (CNN/Money) - Worries about Iraq, the shaky U.S. economy and tepid corporate earnings punished stocks Thursday, setting the markets up for a third week of declines, barring an unexpected rally Friday.

To close higher for the week, the Dow would need to gain 186 points, the Nasdaq would need to gain 20 points and the S&P 500 would need to add 17 points.

Friday brings quarterly results from Dow component Honeywell (HON: Research, Estimates), which is expected to have earned 50 cents per share, down from 55 cents a year earlier. Friday also brings economic reports on personal spending and personal income, the revised reading on consumer sentiment from the University of Michigan and a regional survey of manufacturing.

The Dow Jones industrial average (down 165.58 to 7945.13, Charts) and the S&P 500 index (down 19.75 to 844.61, Charts) both fell around 2 percent, while the Nasdaq composite (down 35.71 to 1322.35, Charts) lost around 2.6 percent. The Dow carved out a fresh 3-1/2-month low, now trading at levels not seen since Oct. 14.

Markets were hit by ho-hum results from three Dow stocks, a record loss at AOL Time Warner (CNN/Money's parent) and further signs of joblessness and stalling economic growth, as well as the growing concern that war with Iraq may be inevitable.

Investors may have also been unnerved by news that a section of the U.S. embassy in Berlin was closed after authorities were told there could be attacks on both the Israeli and U.S. embassies in the German capital.

After the close of trade, Dow component Walt Disney (DIS: down $0.71 to $16.35, Research, Estimates) reported a quarterly profit of 17 cents per share, 2 cents better than expected. Shares of the media company gained 50 cents to $16.85 after the close of trade.

Shares of Hewlett-Packard (HPQ: down $1.09 to $18.20, Research, Estimates) lost 5 percent, amplifying the Dow's decline as the afternoon wore on, perhaps in response to some comments made by a rival the previous day, said Kevin Hunt, a technology analyst who covers the stock for Thomas Weisel Partners.

PC-maker Gateway (GTW: down $0.19 to $2.73, Research, Estimates) reported a worse-than-expected quarterly loss late Wednesday that compared with profit a year earlier. In its conference call, the company alluded to a competitor that was "stuffing its retail channels," or reporting earnings when a lot of product is sitting with retailers unsold, Hunt said. "It was interpreted as being a comment about Hewlett. I don't think it's particularly true, but that could be hurting the stock today."

"You also have a lot of hardware and chip stocks pulling back from recent highs, and H-P is getting pulled into that," he added.

Shares of AOL Time Warner (AOL: down $1.96 to $12.00, Research, Estimates) fell sharply after the company said late Wednesday that its net loss for 2002 amounted to nearly $99 billion, more than any company has lost before. The monumental loss was due largely to charges the company took to reflect the shrinking value of its AOL division. In addition, CNN founder Ted Turner, AOL Time Warner's largest individual shareholder, announced his resignation as vice chairman. The stock was the NYSE's most-active.

Semiconductor, networking and hardware selling bled into other technology shares, with Dow stocks such as Intel (INTC: down $0.87 to $15.79, Research, Estimates) and Microsoft (MSFT: down $1.68 to $48.23, Research, Estimates) losing ground.

On the upside, shares of memory chipmaker Rambus (RMBS: up $0.96 to $12.65, Research, Estimates) surged more than 9 percent and the stock was among the Nasdaq's 10 most-actively traded issues after it received a positive patent ruling Wednesday. A federal court threw out rival Infineon Technologies' fraud claim against the company and revived Rambus' claim that Infineon had infringed its patents. Shares of the stock had rallied 50 percent in the previous session.

"No one wants to stick their neck out," said Ram Kolluri, chief investment officer at Global Value Investors. "There's nervousness about Iraq, oil prices are up and the dollar isn't, and the earnings season is mostly over with and it was just mixed."

But stocks are likely to break out of the range they've been stuck in fairly soon, Kolluri said, noting that with such pent-up demand, military action or even just the belief that the U.S. is acting assertively could propel the market into a big, short-term upswing.

In an open letter from their leaders published in newspapers around the world, eight smaller European nations showed their support for the United States' pitch for military action against Iraq. But Europe's heavyweights, France and Germany, members of the United Nations Security Council, remain opposed to war and want to see U.N. weapons inspectors spend more time in Iraq looking for weapons of mass destruction.

"If there's military action, it's going to have to be soon," Kolluri added. "The heat is oppressive come March, April, May in that part of the world. In the desert it can reach 120 degrees. So I have a feeling something will happen in February."

Wall Street took no comfort from news that gross domestic product in the fourth quarter grew at a measly 0.7 percent rate, a number that was lower than the market's modest expectations of a 0.9 percent advance. Separately, some 397,000 people filed for the first time last week to get unemployment benefits, 12,000 more than economists had expected and dangerously close to the 400,000 level that indicates a weakening labor market.

Market breadth was negative. On the New York Stock Exchange, declining stocks beat advancers by 2 to 1 on volume of 1.48 billion shares. On the Nasdaq, losers were ahead of gainers by 11 to 5 as 1.41 billion shares changed hands.

Bonds rose 13/32 of a point in price, pushing the yield down to 3.97 percent. Bond prices and yields move in opposite directions.

The dollar rallied against the euro. The U.S. currency also rose sharply against the yen. The bounce was seen as a technical correction for the ailing dollar, helped by the European show of support for Washington against Iraq.

Light crude oil gained 22 cents to trade at $33.85 a barrel in New York. Gold gained $2.30 to $369.70 an ounce in New York.